Oil prices hovered below a three-year high last week, but the rapid run up in oil prices from below USD45 a barrel just seven months ago has lead many investors to ask if USD70 a barrel will mark the peak for the market?A production-cutting pact between the Organization of the Petroleum Exporting Countries, Russia and other producers has given a strong tailwind to oil prices, with both benchmarks last week hitting levels not seen since December 2014.
However, the International Energy Agency (IEA) acknowledged in its latest Oil Market Report that the recent rally in oil prices came on the heels of significant tightening, but that the supply picture still looks ominous.
The rally in Brent prices to USD70 was driven in part by some unexpected interruption and geopolitical tension, including the possible unraveling of the Iran nuclear deal, the closure of the Forties pipeline a few weeks back, disruption in Libya, and the steep decline in Venezuela’s oil production.
Inventories also continue to decline (for the time being), and even picked up pace at the end of last year. The IEA said that OECD commercial stocks declined by 17.9 million barrels in November, a pace that was twice as fast as the five-year average. In December, preliminary data suggests the declines were even stronger.
“The oil market is clearly tightening,” the IEA wrote. In this sense, it is not as if the surge in positioning from hedge funds and other money managers is unjustified — the underlying fundamentals point to a real tightening underway in the physical market for crude oil.
However, soaring supplies from the US and other non-OPEC countries threaten to stall the rally. The IEA raised its forecast for US production growth to 1.35m barrel a day this year, making up by far the biggest chunk of supply growth outside Opec countries. US oil output should surpass Saudi Arabia this year.
It isn’t just the US adding new barrels to the market. Brazil and Canada are two other non-OPEC countries expected to post strong gains, although, unlike short-cycle shale, both countries have projects set to come online that were planned years ago.
Even after factoring in some non-trivial declines in output from Mexico and China, the IEA sees non-OPEC production rising by 1.7 mb/d in 2018, a figure that represents “a return to the heady days of 2013-2015 when US-led growth averaged 1.9 mb/d,” the IEA wrote.
For oil bulls, that should be a pretty threatening figure because demand is only expected to grow by 1.3 mb/d this year. The IEA acknowledges that its demand estimate could be conservative, but it takes into account the fact that some demand destruction could occur from higher prices. OPEC pegged demand growth at a healthier 1.5 mb/d, but even that figure is swamped by the 1.7 mb/d of new supply.
The result could be a return to increases in inventories, testing the current rally in prices. The IEA sees a “modest surplus” in the first half of the year, followed by a “modest deficit” in the second half. As such, forecasts for USD60-USD70 for Brent seem reasonable, but that “we should expect a volatile year.”
For now, oil prices are struggling to hold onto their gains — Brent has hit the USD70 per barrel threshold, but has fallen back at that resistance level.